Thursday, July 10, 2008

Market Mayhem - Is this a bottom?

In my 26th June Market Mayhem Post I wrote

. . . . . . The market is facing three important risks -

~ Inflation, INR depreciating and leading to higher prices of imported goods

~ Higher crude prices causing worsening of the fiscal deficit

~ Uncertainty about the government at the centre If investors get answers to these questions, markets would recover swiftly . . . . . . .

Market in now trying to justify its position in light of these developments. The inflation picture has been answered somewhat by the Finance ministers when he said that it can touch 13%. I still feel inflation has the capacity to go beyond that. We must remember that its just the WPI numbers that the government looks at and talks about. It is not the inflation in the hands of consumer.

RBI's policy of raising the rates too late shows how it has fallen behind the curve and is now trying to catch up with it. Indian inflation is largely driven by a mix of domestic demand and supply dynamics and international commodity prices. The important point to note that it is not only the domestic money supply is well above 21% and way above the RBI guidance of 16.5% to 17%. With this kind of influx of money into the system and such a high level of inflation the INR will depreciate to 44.20 levels in next few weeks if RBI fails to defend it.

Crude oil has formed a ending diagonal pattern right at the top and fallen $9 from the top. This has been accepted as a welcome fall by the markets and we saw a surge of 5%. Lets see the following facts.

If RBI doesn't raise rates from here in the next few weeks we have the same interest rate differential with other currencies. So can assume there wouldn't be a material rise in inflow of funds for INR.

At current inflation level there is little incentive to hold INR. Equity markets are already dow and not in a great favour globally, though some investment demand has started to kick in.

If crude prices fall and RBI is unable to defend the rupee we might have a serious problem. The rise in the equity markets would only be sentiment and wouldn't sustain.

Moreover , India has paid an average $7.7 billion a month for oil imports so far this year, compared with $5.4 billion in 2007, government data show. That widened the trade deficit to a record $10.8 billion in May.
Combining the M3 and the record deficit along with RBI's reluctance to raise rates is what is hitting the markets badly. The M3 picture is clearly suggesting the trend of inflation figures.

What does this suggest? It suggests, any interest rate hike should be greeted with open arms. INR appreciation would be another cheer for the market. But do not read too much into fall in crude oil price, it might hit back. Crude oil prices will make a difference when they fall below $120 and INR appreciates. This expectation would start getting factored into the markets but a structural bull run will not get hampered in crude oil unless it trades below $125 for a week or so.

As I wrote last time that any shake out of the present government will be healthy for the markets, the markets didn't touch the post announcement lows. In one sense the change of supporting allies will not help much but it has assuaged some worries. If the government fails to prove its majority at the centre it could mark as an important bottom for the equity markets.

Looking at the price structure of the NIFTY 50 it seems the downtrend is still the dominant trend. There is no change in the wave count though a short term bottom may get confirmed as and when Nifty closes above 4280 levels. At this closing the short term target of 3600 may looks uncertain as this is the chief risk level which will call for a large up move to 4450 and beyond. The 5th wave of corrective 'C' seems to have ended but it would take time to see whether prices confirm this assumption. From an Elliott wave perspective there is hardly anything significant to trade. There is no profitable risk reward trade unless prices resolve meaningfully.

4093 should be a strong support and should hold for prices to move past 4280. Level of 4300 will call for some shorts with small stops for traders who like to be adventurous.

Markets move in 4 different wave in general.

a) Trending and non-volatile (equity market bull run in major indices)
b) Trending and volatile (recent 2008 crude oil spike)
c) Sideways and volatile (post corrective moves)
d) Sideways and non-volatile (low participation, generally bottom of a stock market index)

Indian stock market indices have come off from category a to b( correction) and now to C. So we might assume d to be witnessed unless we see a sharp turn to category a. There is lot of greed left in investors which might end with another strong downward push, but a possibility of sharp up move before that cannot be ruled out.

Financial advisor are witnessing good amount of inflow into mutual funds for investment as markets have touched the 400 mark. This hardly calls for a bottom. Tough crowds are always right, but they are wrong only at the point of reversal. So it is better to play the wait and watch game before plunging into the markets with all your stash.

The important point to note here is that markets may greet interest rate hikes with joy rather than gloom. Rationally any attempt to bring down the inflation problem is good for stocks. With call money markets now quoting 9% and above INR may see respite from depreciation and help stocks recover. A fall in the government at centre might be greeted positively. However any free will shown by the government in policy making would be an important development.

However markets may still recover due to these changes but the damage that has been caused due to high prices of resource commodities is deepening everyday unless these commodities cool off. We might enter a lean patch before the next big bull run commences. According to Elliott wave pattern we might have formed just the wave 'A' of the correction and might fall more in the next one year or so. But this is just another assumption and will take time to resolve.

The sectors which can give huge returns from current levels looks attractive. IT, pipes, FMCG and energy would do well. These are the sectors which to well in the end of a huge bull run and beginning of a new bull run. We might bet money on one of the two.

Due to a problem with hardware of my PC I couldn't publish graphs of the Elliott Wave counts. Graphs will be published in a week or so.

sahil kapoor
Comments are welcome.

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